Association for Public Policy Analysis & Management

As the largest greenhouse gas emitter in the world, China has promised to cap its total carbon emission around 2030 in its Intended Nationally Determined Contribution (INDC). A national cap-and-trade system, which is planned to be launched in 2017, is viewed by scholars and policy makers as a key strategy for China to achieve its climate change mitigation goals. A significant challenge that China needs to address is to allocate the emission allowances to different provinces, industries, and firms, since different allocation methods in the cap-and-trade system will inevitably create tradeoffs between efficiency and equity. China has highly heterogeneous social and economic development across regions. While the coastal provinces are facing the pressure of excess production capacity, the inland provinces are still in the process of industrialization and rapid urbanization. Therefore, similar to international climate cooperation, China’s cap-and-trade system should also adopt “common but differentiated responsibility” as one of its designing principles.

Besides fairness considerations in regional development, the cap-and-trade system will also impact different industries and different sizes of firms unevenly. The cap-and-trade system is reported to be covering only the large firms in six industries: steel, electricity, petrochemical, cement, nonferrous metal, and, paper mills. According to my preliminary analysis, the system would cover only about 36% of national carbon emission. The limited scope of the system could cause leakage problem in various forms. First, investments are likely to be diverted from the industries covered by the system to industries not covered, causing emissions to increase in the latter. Second, since only the firms above an emission threshold are required to hold allowances, the smaller firms would gain a price advantage over the large firms, and the number of small firms are likely to increase, despite the fact that most of the small firms are less energy efficient than the large ones. In addition, whether the allowances should be allocated for free or be auctioned, and how the revenue from the cap-and-trade system should be spent, are also important questions that need to be carefully studied.

This study will focus on the efficiency and equity tradeoffs of different allowance allocation methods in the national cap-and-trade system. From the standpoint of efficiency, I will assess to what extent the cap-and-trade system can help achieve national emission reduction goals, and whether the emission reductions are carried out at places with low marginal abatement costs. And then I will analyze three dimensions of equity concerns: inter-regional fairness, inter-industry fairness, and fairness between large and small firms. My analysis will be based on a dataset that includes complete carbon emission data for 48 industries in 31 provinces in China. A combination of quantitative and qualitative methods will be applied to analyze the effects of different allocation scenarios.